Riskless Principal

AAA

DEFINITION of 'Riskless Principal'

A trade in a security that involves two orders, with the execution of one of these orders dependent upon the receipt or execution of the other. Riskless principal is defined by the Financial Industry Regulatory Authority (FINRA) as a trade in which a member who has received a customer order immediately executes an identical order in the marketplace, while taking on the role of principal, in order to fill the customer order.

A buy order from a customer would therefore require the member firm to execute an identical buy order in the market as principal, while a sell order would require the member firm to execute an identical sell order in the market. In order to qualify for riskless principal trades, FINRA stipulates that the trades should be executed at the same price, exclusive of a markup/markdown, commission or other fees.

INVESTOPEDIA EXPLAINS 'Riskless Principal'

For example, a broker-dealer who is a FINRA member and receives a customer order to buy 10,000 shares of Widget Co. at the prevailing market price of $10 would immediately buy the 10,000 shares from another member at $10. Since both trades were executed at the same price (excluding commissions), this would qualify as a riskless principal transaction.

On March 24, 1999, the SEC approved amendments to FINRA, then the National Association of Security Dealers (NASD) rules regarding the reporting of riskless principal transactions by market makers in Nasdaq and OTC securities. The rule change, which was effective Sep. 30, 1999, permitted market makers to only report one leg of a riskless principal transaction, rather than both legs, as was the requirement previously.

While market makers are always deemed to be "at risk" when trading from their principal accounts, the amendment was an acknowledgment of the fact that trades undertaken to offset customer orders are riskless. One of the significant benefits of this rule change was a reduction in transaction fees levied by the SEC.

RELATED TERMS
  1. Principal

    1. The amount borrowed or the amount still owed on a loan, separate ...
  2. Securities And Exchange Commission ...

    A government commission created by Congress to regulate the securities ...
  3. Over-The-Counter - OTC

    A security traded in some context other than on a formal exchange ...
  4. National Association Of Securities ...

    The NASD was a self-regulatory organization of the securities ...
  5. Agent

    1. An individual or firm that places securities transactions ...
  6. Market Maker

    A broker-dealer firm that accepts the risk of holding a certain ...
RELATED FAQS
  1. When does the fixed charge coverage ratio suggest that a company should stop borrowing ...

    Since the fixed charge coverage ratio indicates the number of times a company is capable of making its fixed charge payments ... Read Full Answer >>
  2. What is the difference between the return on total assets and an interest rate?

    Return on total assets (ROTA) represents one of the profitability metrics. It is calculated by taking a company's earnings ... Read Full Answer >>
  3. What does a high turnover ratio signify for an investment fund?

    If an investment fund has a high turnover ratio, it indicates it replaces most or all of its holdings over a one-year period. ... Read Full Answer >>
  4. What is the difference between passive and active asset management?

    Asset management utilizes two main investment strategies that can be used to generate returns: active asset management and ... Read Full Answer >>
  5. How can EV/EBITDA be used in conjunction with the P/E ratio?

    Because they provide different perspectives of analysis, the EV/EBITDA multiple and the P/E ratio can be used together to ... Read Full Answer >>
  6. How can a company reduce the unsystematic risk of its own security issues?

    Companies can reduce the unsystematic risk of their own security issues simply by doing the most effective job possible of ... Read Full Answer >>
Related Articles
  1. Brokers

    Brokerage Functions: Underwriting And Agency Roles

    Learning about these various activities can give insight into how securities are issued and traded.
  2. Investing Basics

    Principal Trading and Agency Trading

    Ever wonder what happens behind the scenes when you buy or sell a stock? Read on and find out!
  3. Active Trading

    What Is Warren Buffett's Investing Style?

    Learn the main principles that Warren Buffet uses in assessing a company. His take on value investing may surprise you.
  4. Investing

    Off-Balance-Sheet Entities: An Introduction

    The theory and practice of these entities varies greatly. Investors need to learn what they're getting into.
  5. Fundamental Analysis

    What Is the Quantity Theory of Money?

    Take a look at the tenets, assumptions and challenges of monetarism's principal theory.
  6. Entrepreneurship

    Run Your Personal Finances Like A Business

    The principles that contribute to success in business can also help you achieve your financial goals.
  7. Options & Futures

    Mark-To-Market Mayhem

    Did this accounting convention contribute to the credit crisis of 2008? Find out here.
  8. Investing Basics

    Explaining Assets Under Management

    Assets under management is a metric that measures the market value of assets that an investment company manages for investors.
  9. Investing

    Can You Be Sued for Negative Comments Online?

    It's important to understand the basics of libel law so you can avoid posting statements that might result in a lawsuit.
  10. Fundamental Analysis

    Do Stock Splits Cause Volatility?

    Since stock splits decrease the stock price, do they also increase volatility because shares are traded in smaller increments? Investopedia examines assumptions about this increasingly common ...

You May Also Like

Hot Definitions
  1. Bogey

    A buzzword that refers to a benchmark used to evaluate a fund's performance. The benchmark is an index that reflects the ...
  2. Xetra

    An all-electronic trading system based in Frankfurt, Germany. Launched in 1997 and operated by the Deutsche Börse, the Xetra ...
  3. Nuncupative Will

    A verbal will that must have two witnesses and can only deal with the distribution of personal property. A nuncupative will ...
  4. OsMA

    An abbreviation for Oscillator - Moving Average. OsMA is used in technical analysis to represent the variance between an ...
  5. Investopedia

    One of the best-known sources of financial information on the internet. Investopedia is a resource for investors, consumers ...
  6. Unfair Claims Practice

    The improper avoidance of a claim by an insurer or an attempt to reduce the size of the claim. By engaging in unfair claims ...
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!